The Changing Investment Landscape For Nonprofits

If there were ever a group of nonprofit institutions that could serve as leaders and examples for smaller organizations, the vaunted Ivy League universities might be among the first that come to mind. That's why some were surprised Sept. 19 when the financial managers of Harvard University's $37.1 billion endowment fund reported a "disappointing" fiscal year  . 

What may come as a surprise was not the disappointment of the fund managers but their reason: The endowment had earned a net return of 8.1 percent, a windfall compared to earnings on the average retirement investment account, for example, and something that smaller institutions could only dream of.

The earnings report reminds us that investment outcomes can diverge significantly between the largest and smallest players, especially in the complex field of nonprofit endowment management. With that in mind, what lessons can ordinary nonprofits learn from the heavy hitters like Harvard as they seek to grow their savings, invest it wisely and use it to further its goals and mission?

According to The New York Times, many college endowment funds have yet to release details on their most recent fiscal year performance. However, the data we do have now, as well as lessons learned in the recent financial past, shed some light on the common challenges facing nonprofit fund managers.

While Harvard's "disappointing" year may sound remarkable to some, according to research from endowment management company Cambridge Associates, their concerns are not unfounded. The mean one-year return on investment for more than 400 U.S. nonprofit endowments is 12.7 percent, according to Cambridge. The Massachusetts Institute of Technology, another prestigious university with a large endowment of $14.8 billion, reported a 14.3 percent return for its 2017 fiscal year. 

For comparison's sake, standard U.S. stock market indices like the S&P 500 or the NASDAQ boast historical average returns of roughly 7 percent annually, according to Investopedia. So it might seem arrogant for Harvard's money managers to bemoan an 8.1 percent return as concerning. But it actually highlights a new struggle that many nonprofits now face as they seek to make the right investment choices amid an increasingly complicated and competitive market.

Making investments work for nonprofits

Investing is never a risk-free endeavor, but it can be particularly uncertain for nonprofits, the bulk of which have endowments valued in the low tens of millions of dollars. The task of managing that money falls to the organization's board of directors, who must also spend time working on their primary duties in their role, as well as their day job. Without much time to devote and in some cases only a surface-level understanding of finance, boards can easily fall prey to spending exorbitant amounts on advisor fees, or else run the risk of making unwise investment decisions.

As the Times reported, even Harvard, with a dedicated team of money managers to handle its endowment, has faced issues in the recent past. Along with many other university's the school's endowment had become heavily invested in more risky assets like hedge funds, which have underperformed the broader market while charging high fees.  According to experts who spoke to the Times, investment in these more exotic assets is a primary culprit in the relatively lackluster returns seen by nonprofit endowments recently.

If there is a solution to this very expensive problem for endowment fund managers at nonprofits large and small, it's probably a familiar one: cheaper is better. Just as most ordinary investors are encouraged to stick to "boring," low-fee funds in their retirement portfolios, nonprofit money managers are increasingly choosing to do the same. More nonprofits are shifting finances into index funds and short-term bonds to take advantage of the steady returns these assets typically offer.

While hedge funds have not been entirely removed from nonprofit endowment portfolios, according to financial advisors who spoke with the Times, they are coming under greater scrutiny  . Those experts urged nonprofit board members to look at their spending on management fees in close detail, since this information can be obtuse and hard to find. Total fees charged by one hedge fund cited in the Times' report averaged about 1 percent of assets under management. On the other hand, endowment trustees could expect to pay as little as 0.14 percent in fees if they choose to invest in mutual funds that track a major index like the S&P 500.

Nonprofits should also consider how their endowment is helping advance their mission and overarching goals. One nonprofit foundation mentioned by the Times chose to keep any investments in the most low-risk, low-overhead funds possible. The rest was spent down according to the values of its founder, disbursed as grant money to organizations that championed civic causes like women's rights and the arts.

For the best possible investment outcomes, nonprofits should always follow the advice of a trusted financial professional.